This article first appeared in Livemint
The Reserve Bank of India (RBI) has permitted banks and non-banking finance companies (NBFCs) to reschedule payments on all loans for the period between March and May 2020 to stem the impact of the Covid-19 pandemic. Many banks and NBFCs have followed suit to offer such moratoriums to their customers. However, FAQs—answers to frequently asked questions—put together by the Indian Banks’ Association (IBA) and circulated by the Ministry of Finance categorically state that NBFCs, micro-finance institutions (MFIs) and housing finance companies (HFCs) are not being considered under the scheme. There have also been reports from some NBFCs that they have not been offered such a moratorium on their loans from a leading bank on the grounds that this would not apply to NBFCs.
NBFCs form the last mile link in the supply chain of credit to low income households and businesses, particularly those who are in the business of microfinance, financing of equipment, small business loans and the like. Their customers are those who cannot otherwise receive loans from banks and for whom NBFCs have devised credible ways to service. Let us examine what the fallout of non-applicability of moratoriums on NBFCs could be.
One, most NBFCs serving poorer customer segments, especially the many smaller ones, carry on their books, specialised loans of one or a few kinds. Such holdings of concentrated credit risks means that a majority of their borrowers, especially those who are poorer or more vulnerable to a livelihood shock from covid-19, would be the most in need of the moratorium in order for them to not slip into abject poverty and to find their feet again as quickly as possible. It would be unwise for these NBFCs to deny them this lifeline. However, if NBFCs in turn are denied a moratorium from their bank lenders, this would result in widening asset-liability mismatches and spikes to costs of fresh borrowing. NBFCs may then have to turn down the moratorium lifeline to their customers. Such kicking the can down the road to the last hapless borrower is unfortunate and beats the very spirit of the RBI’s moratorium.
Two, it is possible that NBFCs would be able to hold out for the two months ahead and service their liabilities while also extending the moratorium to their borrowers. Analysis by Crisil, a credit rating agency, found that a significant majority of the top 100 rated NBFCs have liquidity buffer of over two times towards the repayment of non-bank debt due in the next two months. However, uncertainties around the ground realities post 31 May are hard to ignore. It is highly likely that collections efficiency will not return to a comfortable 90% or more immediately and this would mean that defaults on loans would get booked.
Depending on how severe the economic shock, this could lead to increase in defaults by such NBFCs on their loans to banks and to their debt market investors, and possible contagion effects on other parts of the financial system, at which point, more expensive emergency measures may be needed to salvage the situation. Recollect that after the Andhra Pradesh Ordinance in October 2010 and demonetization in November 2016 (which needed the RBI to intervene with supportive measures), the 30+ and 90+ Days Past Due continued to spike well into the next nine and five months respectively.
The IBA’s FAQs could set a strong precedent for banks to leave NBFCs out of the moratorium completely without giving this a deeper consideration. After all, there exists a strong interdependence between banks and NBFCs for bridging the last-mile credit delivery challenge. Commercial banks hold 48% of the NBFC sector’s gross payables according to RBI’s December 2019 Financial Stability Report.
RBI’s long-term repo operations are meant to ensure a timely supply of liquidity to the corporate sector including to NBFCs. But there is a worry that just as with the aftermath of the IL&FS crisis, banks would neglect the smaller and lower rated NBFCs and invest only in papers of very highly rated large NBFCs who are already sufficiently funded and can brave the two-month asset-liability mismatch challenge. This, alongside the challenge of servicing existing borrowings, worsens, rather than eases the liquidity challenge for smaller NBFCs, particularly those whose last-mile borrowers deserve the benefit of the moratorium.
MFIs and those NBFCs in the business of providing micro- and small- enterprise loans are wholesale borrowers who need the moratorium on a war-footing. Many of these lenders form the first formal loan providers for large swathes of Indian citizens who cannot access direct bank credit. There is an urgent need to ensure that there is seamless end-to-end liquidity transmission of the moratorium for these citizens. The RBI and the Ministry of Finance must therefore come out with a statement to clarify this for these categories of NBFCs, and among these, especially those that are lower rated and for whom capital market issuances cannot be a reliable option at this stressful time. While a flight-to-quality and a flight-to-safety are a means to self-correct during financial crises, this pandemic is certainly not one of them.